In a bid to move away from the dollar and other foreign currency denominated trade, the Reserve Bank of India rolled out International Trade Settlement (ITS) in Indian Rupee on July 11, 2022. This was also the first step towards internationalisation of the rupee.

The move was timely as a number of countries in Africa and South Asia were facing acute shortage of foreign exchange in view of a slowdown of their exports and tourism earnings, compelling some of them to restrict trade only through Letter of Credit, and by using limited foreign exchange for essential imports. Increasing OFAC (Office of Foreign Assets Control in the US) sanctions on countries also indirectly supported rupee-based settlement.

In less than a year, almost two dozen countries’ banks have opened Special Vostro accounts in India. However, in such a mechanism, overseas entities face exchange risk since their currencies have to be converted into rupee mostly through cross currency rate, since most of the countries under the mechanism do not have a direct currency rate with Rupee. Banks have agreed to provide a direct exchange rate though using US$.

The double conversion, first in dollar and then in rupee, generally eats away 3-4 per cent of the transaction value. This dissuades overseas entities from availing rupee settlement. Someone has to absorb this cost for this mechanism to be exploited fully.

Local currency

To address this and to enhance bilateral trade relations between India and the UAE, the governments announced local currency trading between the two nations. In local currency trading, entities are permitted to use either of the currencies for exports or imports.

If both sides are dealing in their own local currency, exchange risk is eliminated. Our MSMEs will be a major beneficiary as they are not familiar with the nuances of hedging.

One of the challenges in such settlements, however, is with regard to imports required for such exports. In the usual course, exporters take pre-shipment credit in dollars or euros for imports of raw materials required for exports and liquidate such credit through exports. Natural hedging is available as the value of imports is liquidated by exports. In local currency settlement, however, exporters are susceptible to some exchange risk. Fifty per cent of pre-shipment credits are denominated in foreign currencies.

SEZ units are required to transact in foreign currency as settlement in the rupee is still not recognised by the SEZ policy though Foreign Trade Policy allows it. Early amendment in the SEZ policy will hasten such settlements.

The balance lying in ITS Rupee Accounts is meant for trade or investment. But many entities are purely in the exim business and thus not keen on investment.

Liquidating the rupee

There is another possible situation. For example, company “A” in Russia has exported goods worth ₹50 crore and has a credit of ₹50 crore in its rupee account, which it is unable to use either for imports from or investment in India. However, it should be possible for, say, a UK-based branch of this company to import a product from India worth ₹50 crore and sell to a third country.

The transaction will facilitate exports from India while simultaneously providing an opportunity to Russian entity to liquidate the rupee. Some of the bankers opine that such transactions are permitted while many say ‘no’.

If we consider rupee in the Special Vostro account as free foreign exchange, there should not be any problem as third country payment is allowed, if declared at the time of exports. However, clarity is required to avoid hassles in future.

The writer is Director General, FIEO. Views are personal